Misbehaving | Hidden BrainShankar Vedantam talks to Richard Thaler — father of behavioral economics and author of Misbehaving -- about why we so often fail to act the way we should and how marshmallows can predict the future.

Welcome to HIDDEN BRAIN. I'm Shankar Vedantam. This week, we're going to bring you a conversation I had in front of a live audience with Richard Thaler, taped on Halloween at the Willard Intercontinental Hotel in Washington, D.C. Richard is a professor of behavioral sciences and economics at the University of Chicago and is a well-known author. His latest book is called "Misbehaving: The Making Of Behavioral Economics."

(APPLAUSE)

VEDANTAM: I want to start by asking Richard a real soft-ball question. Your friend whose name is Daniel Kahneman - he won the Nobel prize in economics some years ago - world-famous psychologist, brilliant author. And Danny Kahneman was once asked to describe Richard Thaler to a journalist. And he said that Richard's dominant characteristic, the thing that makes him stand out, is that Richard is lazy.

(LAUGHTER)

VEDANTAM: Can you tell me, Richard, why Danny said that and also why he insists that this was a compliment?

RICHARD THALER: Yeah, what's worse is A, Danny is my best friend, and B, he this was my best quality.

(LAUGHTER)

THALER: To this day, Danny defends this. And he defends A, that it's true, and B, that it's a compliment because he says that it means I'm only willing to work on things that are important. The truth is I'm only willing to work on things that are fun. And that's why I'm here today because I think we're going to have fun.

VEDANTAM: I think that's exactly right. So I first started talking to Richard maybe about 10 years ago. Let me just ask you to give us a short introduction. What is behavioral economics and why has it made such a splash, or why has it been so controversial over the last 15 or 20 years? How is it different than garden-variety economics?

THALER: You know, probably some time in your distant past all of you have had a class in economics. And you know that standard economics assumes that people are highly rational creatures capable of complex calculations, devoid of emotion, never having any self-control problems. And they're complete jerks. So I call these fictional creatures econs (ph). That's short for Homo economicus (ph)...

(LAUGHTER)

THALER: ...The Latin term. And I believe that for the last 50 or 60 years, economists have devoted themselves to studying fictional creatures. They might as well be studying unicorns because there are no econs. Well, there are a few economists I know who are close. But basically, they don't exist. And so we have very fancy models of fictional creatures. And the people I know have trouble figuring out how to divide a check if there are more than three people...

(LAUGHTER)

THALER: ...Occasionally - just occasionally - overeat or overdrink, have trouble saving for retirement, and contrary to economic theory, some at least are willing to donate to National Public Radio...

(LAUGHTER)

THALER: ...Which any economist will tell you is a completely irrational thing to do because you can listen to it for free.

(LAUGHTER)

VEDANTAM: So...

(APPLAUSE)

THALER: OK.

VEDANTAM: So when I first started talking to Richard about 10 years ago, it was for a topic that was called mental accounting. And Richard explained to me that mental accounting is something that we all do in everyday life, and one of the things that I noticed is as soon as Richard started talking, I started thinking of examples from my own life where mental accounting was playing a really, really big role. Let me just start by having you tell us what mental accounting is, Richard.

THALER: So a basic concept of economics is that money is fungible, which means that there are no labels on it. There's a video of Dustin Hoffman and Gene Hackman talking. And Gene Hackman is telling this story about when they were young actors. Hackman goes to visit Dustin Hoffman in his little apartment in Pasadena. Dustin Hoffman has asked him to borrow some money. And then Hackman goes into his kitchen, and he sees these mason jars that have labels on them. And one is rent, and one is utility, and there was nothing in the jar labeled food.

(LAUGHTER)

THALER: And so Hackman says, you don't need any money; you've got lots of money in all these jars. And Hoffman says, yeah, but there's nothing in the food jar. And so that's mental accounting, right? And it used to be, like, certainly in my grandparents' generation, that that's literally how people did it. But we still do it mostly in our heads. And it can make us do all kinds of funny things.

VEDANTAM: So one of the things that's happened over the years is that Richard has actually played a psychotherapist for many people who come to him with their economics problems. And I'm actually going to do the same thing here. One of the things I've noticed about myself is that my wife and I, we share our finances. So we have a joint checking account. We sort of draw from the same pool of money. But I've noticed that when I go to restaurants, I really like it when my wife pulls out her credit card and pays for the bill. Now, I am effectively still paying for it...

(LAUGHTER)

VEDANTAM: ...But it significantly increases my satisfaction with the meal...

(LAUGHTER)

VEDANTAM: ...Not to have to pull out my own credit card.

THALER: OK, so - all right, so here's something that would be even better.

VEDANTAM: Yeah.

THALER: Assuming you and your wife trust one another...

VEDANTAM: Yes.

THALER: ...I recommend that you each get separate checking accounts.

VEDANTAM: What?

THALER: You can still have - my wife and I have this arrangement. So we each have a separate checking account and a joint checking account. And splurges - if I buy myself a new set of golf clubs that I desperately need, or she buys her fourth camera...

VEDANTAM: Right.

THALER: ...Because she travels the world taking pictures - I don't see that.

VEDANTAM: So the splurges come out of your individual checking account.

THALER: Exactly. And gifts - so if your wife picks up the tab, it will come from her account.

VEDANTAM: That's even better.

THALER: Even better.

VEDANTAM: That's really a good idea.

THALER: And, I mean, this is a recipe for marital harmony.

(LAUGHTER)

VEDANTAM: One of the findings of mental accounting is that people keep tabs in their head about how much money they need to make on an annual basis or a monthly basis, or even sometimes on a daily basis. And one of the things that you explained to me was this might explain why it's sometimes difficult to catch a cab on a rainy evening. Can you tell us why mental accounting might make it harder for us to catch cabs on rainy evenings?

THALER: So this is a study that some friends of mine and I did a long time ago in New York. And we were taking a lot of cabs, and we would talk to the cabdrivers. And we would ask them, how do you decide how long to work? They rent the cab for 12 hours, which is a long time to drive in Manhattan. And then they have to take it back within the 12 hours. And a lot of them would say, well, what we do - I set a target. So renting the cab costs me 100 bucks, and then I have to fill the tank up. Let's say that's another 25 bucks. So I want to make a certain amount above that - say $100. And when I hit that, I go home. Now an implication of that is on days like rainy days, where there's lots of demand, they hit their target early, and they go home. Now what would an econ (ph) do? An econ (ph) would drive more on the busy days, and on the sunny day when nobody needs a cab because they're walking, he would go out for a walk himself. Again, if we go back to getting along with your spouse, imagine the guy comes home at 2 in the afternoon, and his wife says, how come you're home so early? And he says, because I didn't make any money. Right, I mean, this is not going to go over well.

VEDANTAM: No it won't. Right.

THALER: So you've got to go out there and drive around for three more hours, burning gas, not making any money.

VEDANTAM: Right, but the interesting thing, of course, is that standard economics would predict that people actually would act rationally - that they would actually work more when the demand is higher, and they would work less when the demand is lower. And of course, what we find is exactly the opposite.

THALER: Exactly.

VEDANTAM: One of the interesting implications of mental accounting is that where the source of people's money ends up changing how they spend the money. So there was a study by Viviana Zelizer, I believe at Princeton University, looking at prostitutes in Oslo. And what she found is that the sex workers were willing to spend money that they received in the form of welfare checks or other kinds of, you know subsidies, on things like rent and important things. But they spent the money that they earned from sex work - they were far more likely to spend that on drugs and alcohol. The source of the money determines how you actually spend the money. I saw a clip from a video - it's called "Welcome To Me," staring the comedian Kristen Wiig - about a woman who suddenly wins a huge amount of money. And I'm going to play the clip for you. And I want you to talk about this idea. So if we could play the video, please.

VEDANTAM: So, Richard, why is this? Why is it that when we receive money from certain sources, the way we think about spending that money changes dramatically?

THALER: You know, one of my colleagues - my fellow troublemakers - is David Laibson, who's just become the chairman of the Harvard economics department. He used to be one of my proteges. Now, you know - anyway.

(LAUGHTER)

THALER: Some of my friends had a roast for me a couple weeks ago because I had a big birthday. And he was telling the following story. A bunch of us were invited to Washington - must have been 15 years ago, when David was a struggling young assistant professor - and did something for the National Institute of Health. And they give us a $200 honorarium for the day. So I was saying, you know, this is ridiculous. We don't work for $200 a day. We have to go out and spend this money on dinner. And so we went out and had a good dinner - you could get quite a good dinner for $200 15 years ago. Now, David was not happy about spending $200 on dinner. And he now claims it was more like 300 when I got done with the wine.

(LAUGHTER)

THALER: But, you know, this was my way of thinking - I'm not going to work for $200, but I'm happy to have a good dinner as a result of helping out the NIH.

VEDANTAM: Yeah. So studies have found also, for example, that if you want to reward employees at the end of the year, giving them a cash bonus is very different than giving them a vacation, that even though you are giving them the same amount of money - you're giving them, let's say, $500 as a bonus versus $500 as a vacation - people report being significantly happier when you give them the vacation than when you give them the cash.

THALER: Yeah.

VEDANTAM: Why is that?

THALER: Well, because if you give them the vacation, they get to go guilt-free. I rediscovered this last week with my daughter, and I made a mistake. And it's a mistake I, of all people, shouldn't have made, but I had good reasons. And I was well intentioned. So my daughter's a Mets fan, and one of the Mets's pitchers happens to be a neighbor. So she was an avid Mets fan, and I thought it would be nice to buy her two tickets to one of the first-round games when her neighbor was pitching. But it was - I got this idea late. So I went online, and I found that I could get tickets for about $400. And - but I didn't have time to buy the tickets and mail them to her, so I sent her an email with a link to this website saying look, it looks like you can get tickets for 400 each. I'm going to send you $1,000. Buy two tickets on this website. And she had already expressed great excitement about getting to go to this game. So I sent her that email. I get back a text - LOL. This is just like one of the examples from your book.

(LAUGHTER)

THALER: If you send me $1,000, I'm not going to spend it on baseball tickets.

(LAUGHTER)

THALER: So - now, she would have been happy if I had sent her the tickets. For sure, they would have gone to the game. But I send her the $1,000, nothing. So I didn't send her the thousand.

(LAUGHTER)

VEDANTAM: More of my conversation with behavioral economist Richard Thaler after this.

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(MUSIC)

VEDANTAM: This is HIDDEN BRAIN. I'm Shankar Vedantam. Back in the 1970s, Stanford psychologist Walter Mischel conducted a series of experiments that came to be known as the marshmallow test. Small children were put in a room and told they could either get one marshmallow right away, but if they stayed in the room and didn't eat the marshmallow, they would get a second. Children who tried not to eat the first marshmallow came up with ways to distract themselves. Watching these children on video is hilarious.

(SOUNDBITE OF EXPERIMENT VIDEO)

UNIDENTIFIED WOMAN: All right, here's the deal - marshmallow for you. You can either wait and I'll give you another one if you wait, or you can eat it now. When I come back, I'll give another one so then you'll have two. But stay in here and stay in the chair until I come back, OK?

VEDANTAM: I played Richard Thaler a video of a marshmallow test in progress where a small boy tries desperately not to eat the marshmallow placed in front of him. At one point, he leans lovingly into the marshmallow and takes a great big sniff and then sadly looks away.

(SOUNDBITE OF EXPERIMENT VIDEO)

UNIDENTIFIED WOMAN: How'd you do? Did you do good? You did?

UNIDENTIFIED CHILD: Yeah.

UNIDENTIFIED WOMAN: You wanted to eat it, didn't you? Yeah. So did I tell you I'd give you another one? OK. Now you can have both.

VEDANTAM: The excited boy crams both marshmallows, chipmunk-style, into his mouth.

(LAUGHTER)

VEDANTAM: So talk about self-control, Richard. Why have classical economics ignored the idea that humans have trouble with self-control?

THALER: So economic theory says that we optimize and that we always choose what's best for us, so that includes self-control. And so, you know, in these experiments, if you'd rather have two marshmallows than one, you should be willing to wait ten minutes. But, as you know, obviously, kids have less self-control than adults, so this experiment kind of exaggerate that. But what you get from those videos, those precious videos, is the real important idea, which is that self-control is work. Resisting temptation is work. This is important, you know, 30 percent of Americans are obese. Half of Americans are not saving enough for retirement. So these are enormous problems that we, as a society, face. And they are, at their core, because exerting self-control is difficult. In some of these marshmallow experiments, they used Oreos. And my favorite one of these - in one condition, there was a kid and he had three Oreos in front of him. And he could have one now, but he was looking at the three. And what he does is, as soon as the person leaves the room, he opens up the Oreos, licks out the middle and then puts them back together.

(LAUGHTER)

THALER: And I have a deep suspicion - these were done many years ago at Stanford - I'm pretty sure that guy is Bernie Madoff. But...

(LAUGHTER)

VEDANTAM: There's interesting work that you've cited by George Loewenstein and others, looking at the difference between hot and cold emotional states, which is that if you ask me right now, would you be able to resist having dessert at lunch, I would say, yeah, sure, I can probably resist having dessert at lunch. But an hour-and-a-half from now, when I'm really hungry, and I'm sitting down at the table, and there's desert in front of me, the person who I am at that point is very different than the person I am right now.

THALER: Right. So, you know, we can all relate to that. We all know the hazards of going to the grocery store hungry. And let's say you're there on Thursday, and you missed lunch. And it's 6 o'clock. And you're buying dinner not just for tonight, but also for Saturday. Now, your hunger now should not affect the size of the roast you buy for Saturday. But, you know, you'll buy a bigger roast.

VEDANTAM: Yeah. The other thing of course we often do sometimes when we have problems with self-control is that we try and have an external enforcer. We try and appoint somebody who will help us run that kind of self-control. This of course goes back to the old idea, the myth of Ulysses who was sailing by the sirens. He was afraid he was going to drift close to the sirens. And so Ulysses had his men bind him to the mast of his ship, so they would be able to sail close to the sirens and hear the sirens' song without actually being tempted to go toward the sirens. So people have tried variations of this on all kinds of things to try and address our - the temptations we expect to face in the future. I came by a very nice clip from the TV show "Curb Your Enthusiasm," where Larry David is essentially asked to be the enforcer for one of his friends. Take a look at the clip.

(SOUNDBITE OF TV SHOW, "CURB YOUR ENTHUSIASM")

SUSIE ESSMAN: (As Susie Green) So are you hungry?

LARRY DAVID: (As Larry David) Starving.

ESSMAN: (As Susie Green) Good, we've got a great meal. And some fabulous desserts, which by the way, I need you to keep me away from no matter what.

DAVID: (As Larry David) OK.

ESSMAN: (As Susie Green) Yeah, 'cause I put a lot of time into this. I need, like, a dessert referee.

DAVID: (As Larry David) All right. I'm your guy.

ESSMAN: (As Susie Green) You promise?

DAVID: (As Larry David) Yeah, I promise.

ESSMAN: (As Susie Green) OK, I'm counting on you.

DAVID: (As Larry David) (Laughter)

ESSMAN: (As Susie Green) (Laughter) No, I'm just going to have a bite.

DAVID: (As Larry David) Oh no, no, no.

ESSMAN: (As Susie Green) Just a bite, come on.

DAVID: (As Larry David) You know what, you told me specifically not to let you have any dessert.

ESSMAN: (As Susie Green) But you know what? I'm changing it. And this is now I'm saying thank you for helping me, I'm going to have some cake.

DAVID: (As Larry David) No, no, but you can't change it. That's why you say no matter what. This is the what. That's why you asked me and not these other people - because you knew I wouldn't let you.

ESSMAN: (As Susie Green) Larry, give me the cake.

DAVID: (As Larry David) She told me not to let her have the cake. She said no matter what.

(LAUGHTER)

VEDANTAM: So...

THALER: That is the hot-cold empathy gap. So when she was in the cold state, she didn't want any dessert. When she was staring the desert in the face, you know, let me at it.

(APPLAUSE)

VEDANTAM: Thank you all so much, and thanks to Richard Thaler.

(MUSIC)

VEDANTAM: That was behavioral economist Richard Thaler. His latest book is called "Misbehaving: The Making Of Behavioral Economics." HIDDEN BRAIN is produced by Kara McGuirk-Allison and Maggie Penman. Max Nesterak is our news assistant. Special thanks this week to Jennifer Longmire-Wright, Sherry Thomas, Neil Tevold (ph), Andy Huether, Brian Jarvo and Jay Sziz (ph). For more HIDDEN BRAIN, you can find us on Facebook, Instagram, and Twitter, and sign up for our newsletter by emailing us at hiddenbrain@npr.org with the word subscribe in the subject line. I'm Shankar Vedantam, and this is NPR.

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